Revolutionary road: recycle assets to create new ones

Arun Jaitley’s budget has a potentially revolutionary proposal, which he called “asset recycling” in an interview. The government constantly lacks funds for badly needed infrastructure. Jaitley’s solution is for government undertakings to routinely sell existing assets, and use the sale proceeds to finance fresh investment.

So, the government can sell old roads to finance new ones; sell old ports to build new ports; and sell old power stations to build modern ones. Public sector entities can sell entire subsidiary companies, or projects, or vacant land to finance fresh projects.

The greatest potential lies in recycling infrastructure. Instead of depending on money from the stressed budget, infrastructure sectors can raise all the equity they need by selling old assets. Instead of building in order to own and run, the government should build in order to sell. This proposal was made explicitly by the Kelkar Committee on Public Private Partnerships (PPP). Jaitley has accepted it. Conceptually, this transforms the role of the state. In British colonial times, many private sector railways, ports and power stations came up. But after Independence, Nehruvian socialism mandated that the state should own the commanding heights of the economy, including infrastructure.

From a market-friendly viewpoint, the government’s role is to facilitate private enterprise. Provision of infrastructure is crucial for this. Providing roads and electricity to every habitation, or ports and airports for international connectivity, can hugely improve business opportunities. Some of these sectors require massive funds, carry big commercial risks, and are unprofitable (no villagers will pay tolls on rural roads). The government has the greatest capacity to raise money and take risks, since it can use tax revenues rather than commercial capital. Hence it has dominated infrastructure everywhere.

But while the government has a major role in building infrastructure, should it maintain and operate roads or power stations? No, not at all. Once the commanding heights have been built, they can be sold to private entities for routine operation.

This reverses the conventional thinking. When the government ran short of funds after economic liberalization, it switched to PPPs to fill the financing gap. Private companies were asked to build, operate and then transfer infrastructure to the government (the BOT approach). PPPs expanded at a dizzy rate in the 2000s, and once-unknown companies like GMR, GVK and Lanco became infrastructure giants. The 12th Plan (2012-17) aimed at investing one trillion dollars in infrastructure, of which half was to come from the private sector.

Alas, this proved a fantasy. Many older PPPs bit the dust. The reasons included delays in land acquisition and environmental clearances; the failure of traffic to meet optimistic projections; the lack of gas or coal to fuel power stations; and sundry problems in financing and clearances. Many PPP projects were financed with 70% debt and only 30% equity. So, any delay implied huge interest payments that were unmatched by revenues. The projects sank. The PPP model was fundamentally unsound. Construction is the riskiest part of an infrastructure project, when unanticipated delays and glitches are common. Major infrastructure projects the world over have suffered huge cost overruns. The PPP model entrusted construction, the riskiest part, to the private sector, to be transferred to the government after the risky stage was over. This placed the maximum burden of risk on heavily leveraged private players, who were least equipped to bear it.

The Kelkar Committee suggested reversing this. It said the government, which has the greatest risk-bearing capacity (it can always use tax revenues to rescue a project) should build projects, and operate them in the initial phase when revenues are uncertain. Once the project is firmly established and revenues are steady and predictable, it can be sold to private players (including international ones) who will pay a high price for utilities with stable revenues. The sale proceeds can then be recycled into new projects.

The old PPP model had the private sector building, operating and transferring a project to the government. The new model has the government building, operating and then transferring projects to the private sector. This reversal makes excellent sense.

Jaitley has asked Niti Aayog to identify assets for recycling. Instead of getting buried in case-by-case examinations of every government undertaking, Niti Aayog should quickly formulate procedures for selling old infrastructure assets.

Privatization has proved politically difficult because of trade union opposition, and will not happen unless Modi throws his weight behind it. But asset recycling is politically less challenging. The government once operated every jetty in every major port. But in recent years, jetties have been auctioned to private players for operation. This has drawn no political flak. It shows the way for other infrastructure projects too.